ENERGY GUEST BLOG -- MATT BRAKEY

Capacity price auction results better, but far from great

Blog Entry: June 21, 2013 7:00 AM | Author: MATT BRAKEY

Matt Brakey is president of Brakey Energy, an energy consulting firm in Shaker Heights that works with some of Ohio's largest energy users.

This time last year, Northern Ohio energy users received some very bad news: The results of the capacity auction meant end users in FirstEnergy Corp.'s Ohio territory would pay exponentially higher capacity rates for the one-year period beginning June 2015. By exponentially higher, I mean prices 13 times current levels, and the highest prices ever seen in the history of these auctions.

Most Ohio energy users currently are paying capacity costs amounting to a few tenths of a penny per kilowatt hour. Due to last year's auction, capacity costs for FirstEnergy's Ohio customers are set to jump to as much as three cents per kilowatt hour beginning June 2015. This will become the second-largest bill charge for many users, second only to the energy component itself.

Fortunately, the auction held last month cleared at one-third of last year's unprecedented price. This auction set the capacity price for the one-year period beginning June 2016. So, can FirstEnergy-Ohio customers sit back and declare the auction results good news? Yes and no.

What is capacity?

Electricity is different from many commodities because it cannot be economically stored in large quantities. Electricity has no shelf life; it must be produced and consumed simultaneously. For this reason, there must be sufficient generation — enough “capacity” — to produce electricity when demand on the grid is at its peak. If the amount of electricity generated is insufficient to meet demand during these peak times, the lights go out.

In order to ensure there is sufficient capacity, all FirstEnergy-Ohio customers pay capacity costs, either directly or indirectly, as a component of their electric bills. Capacity costs are determined by periodic auctions run by PJM Interconnection, the wholesale electric market that serves Ohio and many other Midwest and East Coast states. Under ideal circumstances, each auction would set capacity costs for the entire wholesale market.

However, as a result of aggressive Environmental Protection Agency regulations, several coal-fired power plants in Northern Ohio and Northwest Pennsylvania are being deactivated. Because these local closures do not impact the entire PJM region, PJM carved out an independent zone to address extreme intra-region capacity constraints. This zone, called the American Transmission Systems Inc. (ATSI) zone, includes all of FirstEnergy-Ohio territory. It independently set its own clearing price for the period beginning June 2015.

The 2016-2017 auction results

Narrowly looking at price, the results of last month's auction were good news for FirstEnergy-Ohio users and the PJM region as a whole. The significantly lower capacity price was a byproduct of additional supply and flat demand. The two primary supply drivers were new natural gas generation units and a near doubling of capacity imported from outside of PJM. This import capacity was primarily sourced from states to our immediate west.

The bad news is that, despite planned transmission line upgrades, the ATSI zone once again set a separate clearing price relative to the rest of PJM. In other words, the zone still suffers from capacity constraints not present in the rest of the market. A repeat of the price decoupling experienced in the 2015/2016 auction was universally unexpected by major stakeholders, including PJM.

In the 2015/2016 auction, the ATSI zone cleared at $357.00 per megawatt-day, while the rest of PJM cleared at $136.00 per megawatt-day. This translates to a capacity price 163% higher in FirstEnergy-Ohio territory than the rest of the wholesale market.

In the recent 2016/2017 auction, the ATSI zone cleared at $114.23 per megawatt-day, while the rest of PJM cleared at a depressed price of $59.37 per megatwatt-day. This translates to a capacity price 92% higher in FirstEnergy-Ohio territory than the rest of the wholesale market.

It is noteworthy that the price gap between the ATSI zone and the rest of PJM narrowed on a percent basis, but still remains sizable. Due to this continuing gap, I am concerned that a similar outcome could repeat itself in future auctions. If the ATSI zone continues to clear at levels twice that of the rest of PJM, FirstEnergy-Ohio remains vulnerable to high capacity prices through the end of the decade.

Thie diagnosis

A doctor says to his patient, “I have some good news and bad news.” That patient asks, “What's the good news?” The doctor replies, “They're naming a disease after you!”

Our region's disease is our unique capacity constraints. Until these constraints are alleviated and the zone sets a clearing price in line with the rest of PJM, end users must remain vigilant in their capacity cost management.

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